PSA Peugeot Citroen's board has approved a plan for an alliance with Dongfeng in which the Chinese carmaker and the French state would buy large minority stakes at a 40 percent discount to Peugeot's current share price, a source familiar with the matter said.

The board agreed to enter final negotiations on a 3.5 billion euro ($4.8 billion) share issue that would see France and Dongfeng Motor Group take matching 20 percent holdings, the source said on Wednesday, speaking on condition of anonymity.

Peugeot employees work on the assembly line at the Dongfeng PSA Peugeot Citroen factory in Wuhan, capital of central China's Hubei province, Nov 17, 2006. [Photo/Agencies]?

The capital increase would be priced at below 7 euros per share, and perhaps as low as a 6.85 euro indicative offer from Dongfeng, the source said. Peugeot's shares closed at 11.50 euros on Wednesday.

A spokesman for Peugeot declined to comment on the alliance talks. Dongfeng officials could not be reached after hours in Wuhan, China. The French government also declined to comment.

Peugeot, one of the carmakers worst hit by the European market slump, is cutting jobs and plant capacity to try to halt losses within two years.

The two companies have been in talks for months to extend cooperation to other Asian countries after a multibillion-euro share issue in which Dongfeng and the French government would acquire significant stakes, sources have said.

The Financial Times reported they plan to transfer some Peugeot technologies to Dongfeng while targeting new markets in southeast Asia.

The hefty discount on the proposed deal, approved by Peugeot's board on Tuesday, reflects worsening conditions and currency headwinds since the company pledged to halve its cash burn to 1.5 billion euros this year, the source said.

Under its outline terms, Dongfeng and the French state would each hold about 20 percent of Peugeot after a reserved share sale to the French state and Dongfeng and accompanying rights issue for existing shareholders.

The founding Peugeot family would lose control as its stake was diluted from 25 percent to 15 percent even after acquiring some new stock in the rights issue, the source said.

The effect would be even more dilutive for 7 percent-shareholder General Motors?or any other existing investors that turn down the chance to buy new shares. Peugeot hopes to conclude the deal in January or February, according to the source.

In a move that may help secure the new funding from Dongfeng, Peugeot last week named former Renault No 2 Carlos Tavares as its next chief executive.